Is corporate hedging always beneficial? A theoretical and empirical analysis

This paper investigates, theoretically and empirically, the impact of corporate hedging activities on firm value/performance. In a perfect market, with self-less management, aiming to maximise shareholder wealth, it may be expected that hedging would improve firm performance and add value. Our major contribution in this paper is that we first demonstrate theoretically the conditions under which hedging can increase or decrease firm value. Our theoretic model demonstrates that the ambiguous relationship between hedging and firm value may be due to a subtle combination of economic (managerial self-interest, agency problems/moral hazard, managerial ability, managerial risk aversion) and behavioural factors (overconfidence). Our empirical analysis confirms the ambiguous effect of hedging on firm performance. Empirically, we focus on the use of derivatives in the corporate hedging of three types of financial risk (foreign currency, interest rate and commodity price risks), and examine the effect on value and performance of listed UK corporations during 2005–2017. We demonstrate that the positive or negative effects of the hedging strategies varies significantly across both the financial risk that is hedged and the type of derivatives contracts used in the hedging as well as the time period in consideration.